Educational Articles

Whether investors are looking at the fast food or casual dining arenas, they often consider numerous sales performance indicators including speed of service, taste and quality of food, price elasticity of demand, value proposition, name recognition, footprint, marketing, customer service, as well as restaurant cleanliness and ambiance. Although conventional research can usually provide investors with sufficient understanding of where a company’s strengths lie, some may find it prudent to supplement this information with an actual restaurant visit to gain more astute insight into current food offerings and service procedures.

Sales carry significant weight among restaurant investors as they can have a meaningful impact on the bottom line. This crucial fundamental is normally comprised of comparable restaurant sales (aka “comps” or the year-over-year sales gain/loss of restaurants open for more than one year) and new store receipts. When comps rise without the help of heavy promotional or marketing activity, significant operating leverage can take place. New store sales are conditioned by efficient rent negotiation and shrewd selection of profitable domestic and international locals —with younger firms having a greater opportunity to add units without cannibalizing existing business. In addition to the company-specific factors mentioned above, consumer confidence, discretionary spending trends, and inclement weather can all influence revenues.

Below the top line, some restaurants must worry about labor costs and availability —which is normally influenced by minimum wages laws and the unemployment rate— while others simply get a percentage of franchisees’ revenue. Most restaurants that compete in the same category face similar costs/benefits from fluctuating food prices. Infrastructure and occupancy costs arguably have the most variation between restaurant chains. Nonetheless, due to the tendency for a restaurant’s costs to be somewhat less controllable than sales, we have focused our attention on the top-line growth for the purposes of this screen.

The 30 companies included in the Restaurant Industry have been screened to identify those with strong sales growth over the past year. This suggests favorable response to new menu items, the ability to withstand shifting consumer tastes, and optimal store expansion techniques, among others. Value Line analysts’ 3- to 5-year sales projections are also considered to identify companies with solid prospects for continued success in these areas. The screen turned up a number of appealing names including: Buffalo Wild Wings (BWLD), Tim Hortons (THI) and Darden Restaurants (DRI).

Buffalo Wild Wings

Buffalo Wild Wings owns, operates, and franchises casual dining restaurants in the United States. It features made-to-order menu items, and is best known for its Buffalo-style chicken wings, prepared using an array of different sauces and seasonings. The company’s restaurants are designed to create a welcoming atmosphere, appealing to sports fans and families alike, and include an extensive multi-media system and a full bar. Customers have the option to watch sporting events or other popular programming, participate in trivia competitions, or play video games. The brand differentiates itself from competition through the social experience it offers, and through its unique service model, whereby customers have the choice of ordering at the counter or table.

Buffalo Wild Wings was founded in 1982 at a location near The Ohio State University, and began its franchising program in 1991. Its growth strategy involves opening company-owned and franchised locations in both new and existing domestic markets. As of the end of last year, the company owned or franchised 732 restaurants in 44 states, of which 35% were company-owned and 65% were franchised. It believes it can eventually support a total of 1,400 restaurants in the U.S. BWLD opened its first international store in Canada this year, and plans to establish 50 additional units over the next five years.

The company grows its brand by opening new company-owned stores until a market is penetrated to a point where it has gained marketing, operating, and cost efficiencies. By opening several restaurants at a time in new markets, it is able to quickly build brand awareness. Its U.S. strategy involves moving toward a mix of approximately 40% company-owned restaurants and 60% franchised.

Buffalo Wild Wings has produced impressive top line expansion over the last several years. Indeed, same-store sales were up a healthy 5.7% at company-owned locations during the third quarter. On the expense side, the cost of wings declined 18% year over year, yet the overall cost of sales increased marginally due to promotional activity (such as $3.00 appetizers and drink specials during happy hour). The promotions did drive traffic, however. This, combined with marginally lower labor and occupancy costs, created operating leverage and allowed earnings to grow faster than revenues, which we expect to be the case for the entirety of 2011. The company’s prospects are bright, fueled by the popularity of its signature sauces and seasonings, restaurant ambiance, and domestic and international store count expansion.

Tim Hortons Inc.

Tim Hortons is a Canadian restaurant chain. It is the fourth-largest publicly-traded quick service restaurant in North America based on market capitalization. Tim Hortons appeals to a wide range of consumer tastes with a menu offering breakfast items, coffee, sandwiches, soups, and fresh-baked goods. Former National Hockey League defensive player Tim Horton opened the first store in 1964. Three years later, Ron Joyce, owner of three franchise locations, became partners with Tim Horton, and together they opened 37 stores over the subsequent seven years. The company continued to expand after Tim Horton’s death in 1975, and was purchased by Wendy’s (WEN) in 1995. After the latter spun it off in a 2006 IPO, Tim Hortons again became a stand-alone entity.

As of the beginning of this year, the company operated 3,148 stores in Canada and 602 in the U.S. Tim Hortons’ strategy involves identifying and franchising restaurant locations. Indeed, 99.5% of its system wide restaurants are franchised or run by independent operators. A history of collaboration at the corporate level with restaurant owners helps to grow the business and foster relationships. Owners typically operate three or four locations, giving them a strong stake in both the success of their restaurants and the broader company. Moreover, the “we fit anywhere” concept allows the brand to be adapted for local opportunities. The business model includes vertically-integrated structures, such as warehouse and distribution operations, that supply goods to a large majority of the Canadian restaurants. For example, the company operates four distribution facilities that supply paper and dry goods to these locations. Third-party distributors, by contrast, primarily supply U.S. operations.

Tim Hortons’ prospects look good, as international expansion ought to help the company continue to advance its top line. The first Tim Hortons opened in the Persian Gulf state of Dubai earlier this year, and 120 additional stores are set to open throughout the region over the next five years. New product pushes, such as an expanded coffee line up, are also encouraging. We expect double-digit revenue growth this year, while earnings should advance at a mid-teens rate.

Darden Restaurants

Darden Restaurants is the world’s largest company-owned and operated full-service restaurant corporation. The company currently operates 1,860 restaurants in 49 U.S. states, including 748 Olive Gardens, 670 Red Lobsters, 354 LongHorn Steakhouses, 44 Capital Grilles, 26 Bahama Breezes, and 17 Seasons 52s. In Canada, Darden operates 34 restaurants, including 28 Red Lobsters and six Olive Gardens. The company served over 400 million meals in its last fiscal year.

None of the company’s United States or Canadian locations are franchised. However, five LongHorn Steakhouses in Puerto Rico are franchised to an unaffiliated franchisee, as are 22 Red Lobster restaurants in Japan. Darden also recently entered into a development agreement with an unaffiliated operator to open Red Lobster, LongHorn Steakhouse, and Olive Garden restaurants in the Middle East region.

Darden’s restaurants compete in the full-service segment of the industry, and it aims to grow both by increasing the number of restaurants under its existing brands and by acquiring new chains. Indeed, during its last fiscal year, the company opened 70 new restaurants, predominantly under the Olive Garden and LongHorn Steakhouse names, brands that are also on track to lead new store openings this year. Further, the company announced in mid-October that it will acquire the high-end seafood restaurant Eddie V’s. We are optimistic that this, along with other potential acquisitions, will help boost sales in the coming quarters.

Though Darden posted lower same-store sales at its Olive Garden locations in the first quarter of its fiscal year, it is fighting back with more effective promotions, a new core menu featuring lower-cost items, and a revamped marketing campaign. Management indicated that September sales were strong and comparisons get easier in the coming quarters. It also expects food expenses to rise around 5% in 2012, due mostly to a higher price of protein. Nevertheless, we think that the long-run prospects for the stock are good, and the company has solid opportunities in international markets. This issue also pays a well-covered dividend, with a yield of around 3.8%.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.